What Is Earnings Per Share and Why is It Important To Investing?

When a company goes public and starts trading on the stock market, they’re obligated to tell investors how they’re doing. They can’t fudge facts like how much money they made or how profitable they are. Doing so would mean defrauding shareholders, screwing with their share price. They simply need to deliver good or bad news every three months without skipping a beat.

Every quarterly report (or “earnings call”) features a slew of crucial data. During these reports, you can find the company’s quarterly sales, profit (or loss), expenses, growth percentages, and much more. These data points help investors make informed financial decisions for the future, like buying more stock or selling what they own. They also help analysts predict future quarterly results and what to expect from a company down the line.

Companies also report their earnings per share, an important number that helps investors and analysts alike in charting a company’s success. In fact, knowing a company’s earnings per share might be one of the most important figures to know about a particular stock, as it could mean great success…or imminent failure.

What is earnings per share?

A company’s earnings per share is a simple way to measure a company’s profit. It’s calculated by using the following simple equation:earnings per share

A net income (or net profit) is how much money a company made after their costs, operating expenses, and taxes are subtracted from their revenue. For instance, if a company made $90 million in revenue but their taxes and overhead is $80 million, they have a net income of $10 million.

A company’s outstanding shares are the total shares held by investors. When calculating earnings per share, analysts often use a weighted average of a company’s outstanding shares, as that number could change throughout the year.

A dividend is the money paid by a company to its shareholders, usually stemming from their profit. Companies aren’t required to pay dividends, though many of them do. They’re given to shareholders on a per-share basis at a fixed price. For instance, if a company has 1 million shares and will pay a total of $2 million in dividends, this means each shareholder will get $2 per share. (For more on dividends, read our article here.)

Let’s say Company X has a net income of $10 million. They will also pay $2 million in dividends, and have 1 million outstanding shares. How do we calculate that?

earnings per share

Company X has an $8 earnings per share, or EPS. This means that the company is profitable, though how Company X’s profitability compares to their last quarter’s EPS and their competitors is more important than this single number.

Should you base your investments entirely on a company’s EPS?

Heck no. There are many factors to consider when looking to invest in a company. Earnings per share is just one of them. You can save yourself from making a bad investment by researching things like year-over-year profit/revenue growth and any news that could impact a company’s stock price in the future. Simply looking at a company’s EPS won’t cut it.

If you want to get some idea of how a company is performing, look at their EPS and compare it to previous quarters. Then look at what analysts predicted for the company’s EPS this quarter and other quarters. If a company continuously outperformed expectations and their EPS grew over the span of a year, that’s a pretty good indication of growth. If a company misses expectations and EPS stagnates or shrinks, they might be in for a world of hurt.

Can a company have a negative earnings per share?

Absolutely. Earlier this week, Tesla ($TSLA) announced a quarterly loss for the first three months of 2017. This means that the loss and lack of a dividend divided by the outstanding shares would equal a negative EPS (or -$1.33, in this instance). Tesla’s investors and financial analysts didn’t expect Tesla to post a positive EPS, as the company only did once in the last few years. At the same time, Tesla still posted a lower earnings per share than analysts expected. This caused the stock to dip by over 5% as of this writing, and Tesla remains unprofitable for the time being.